Megan McArdle Moves the Ball Downfield on the Cap-and-Trade vs. Carbon-Tax Discussion

She interfaces with the knowledge base of the ancient Krell and writes:

Megan McArdle: Capped! Ryan Avent has been doing some great posting on cap and trade versus carbon taxes. With all information known, the two are theoretically identical. But in the real world they will differ; the question is how much.

One way to think about it is that we are choosing between two kinds of transparency: transparency to regulated companies, and transparency to voters. Politicians like cap and trade because the connection between the plan and higher energy prices will be less obvious to the voters. For that reason, a libertarian should generally prefer a direct tax.

On the other hand, cap and trade provides more certainty for companies, and a more direct relationship between their actions and profits. So the tax is not always a perfect slam dunk.

On balance I prefer taxes to cap and trade. However, politically, no one is going to enact a carbon tax with gasoline at $4.00 a gallon. Cap and trade is what we're going to get. In practice, that will mean that companies get subsidies to get them to go along (liberals who want cap and trade should concede on this issue to make it easier to pass), while prices rise somewhat. It's not clear to me how big a difference it will make in the long run.

I would say that to first order cap-and-trade and carbon taxes are the same, that there are five second-order differences:

• Cap-and-trade involves less redistribution because the losses of the losers are partially offset by their initial awards of tradeable permits.
• Cap-and-trade runs the risk that the cap will be set at the wrong place and so the price will go damagingly above its social optimum value.
• Carbon taxes run the risk that the tax will be set too low and so the quantity emitted will go damagingly above its social optimum value.
• Carbon taxes have the advantage that the government gets money that it can use for good--either to cut existing taxes that have large deadweight losses or to expand underfunded programs that have large social benefits.
• Carbon taxes have the disadvantage that the government gets money that it can use for ill, and that the recipients and beneficiaries of that ill-used money will then dig in and defend their rent-seeking gains beyond death itself.

and that there are two third-order differences:

• It's easier to get not-too-bright Republicans to vote against something that is actually in their long-run interest if you can demagogue it by calling it a tax.
• It's easier to get not-too-bright Democrats to vote for something that actually is not in their long-run interest if you can demagogue it by claiming that it's just a restriction on the behavior of corporations and not something that directly impacts people.

I don't have a dog in this fight: I think second- and third-order pluses and minuses roughly offset each other. But the substantive case for action seems very clear--and the fact that oil has risen above $100 a barrel without killing the economy just makes it more painful to think of what a hideous waste of opportunity our failure to take Al Gore's advice back in 1993 and put on a carbon tax that IIRC was going to max out at $10/barrel...